John, maybe for your book you could do a bigger piece about liquidity generally, of which bank asset transformation is just one (albeit the signature) case.

The twin fallacies are that liquidity in free markets is due to the operation of the the law of large numbers, and that the level of liquidity is a positive function of market freedom. A better thesis is that without intervention markets tend to consolidation and correlation, and market liquidity is only ever realized, ultimately, as a put option provided by the state under the duress of system failure.

While I like the idea of separating standard banking from running a bucket shop/SP book, it’s not going to fly, is it? NZ can do things we can only dream of because of its simple political structure, so it’s sadly not a good example. Journalistic comment on your idea has focussed on the collapse of state banks in SA and Victoria, where of course the problems arose because those banks had turned into ‘investment banks’. You won’t get a fair hearing from the pollies, either, because they can only remember what they saw on the news, not what King O’Malley did in the days before there was a moon.

I think your argument about a “narrow bank” regulatory system is wrong and actually the lessons learnt around the world indicate that narrow banks are not immune to problems developing.

Firstly, narrow banks are riskier because they cannot diversify their risk. Northern Rock, WaMu and many other narrow banks have collapsed because of this. Northern Rock is a great example of a narrow bank – it was not involved in investment banking or insurance but it collapsed in 2007 at the start of the credit crunch.

Secondly, complex banks diversify risk and offer a one-stop-shop to customers and after all, customers are important unless you think otherwise. Banks want to offer the retail products but also insurance and pensions and if the customer has a business they offer commercial or corporate options for them. This diversifies their risk across numerous areas. RBS is an example of a poorly constructed complex bank – the investment banking arm lost money, the corporate body paid too much for ABN Amro but the insurance arm made money in the year. Arguing that they should not be allowed to do investment banking (yes, I know this is a British bank) means that they will be stuck investing in a domestic housing market pricing bubble which is never a good thing.